Baxter International Inc. (BAX) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. Travis Steed, the Bank of America medical device analyst. And next up this afternoon, we have Baxter, Joel Grade, Executive Vice President and CFO; and Clare Trachtman, Head of everything Investor Relations. So welcome. Maybe just high level before -- I definitely want to dig into some of the different parts of the quarter in HS&T. But just high level, before we get started, maybe just kind of go through how the quarter played out, how you thought it played out and kind of level set everybody there.

Yes, sure. Thanks. And thanks for the opportunity to be here and for your interest in Baxter. I think just generally speaking, we had a strong quarter. And I think we had the opportunity, we beat our guidance on both the top and bottom line. We had 3 of our 4 businesses that exceeded expectations, obviously, offset partially by HST that did not. We had a strong quarter from a margin perspective. We had 180 basis point increase in our operating margins through -- lead primarily by really good work from our ISC group that continues to drive margin expansion. We've had pricing that continues to add to -- especially in markets outside the U.S. that's really continued to add to our margin expansion as well. And so I would say, just in general, it was a good quarter, a lot of good things there. And obviously, some challenges as well.

So obviously, we want to kind of dig into the one challenge area, HS&T.

Sure.

So I guess that business, in total, was down 9% in the quarter. What's the price do the most as the quarter played out? And, I think, you took actions mid-quarter. Just kind of curious how those actions are progressing.

Sure. Yes. Let me break it down between the 2 main parts of the business, between Front Line Care and CCS. I'm going to start with Front Line Care. I think what's -- I'll start with sort of macro factors. What surprised us some was the degree to which the primary care markets were -- had slowed. There is some -- I think this is more than we had anticipated. We did have some year-over-year difficult comps relative to the prior year where we've had a lot of, again, some of the backlog from '22. It was used up in the first part of 2023. But obviously, some of the primary care markets slowed related to spending. Some of that, we think, is related to the change healthcare-reimbursement in the prior year that didn't exist this year. There's also some slowing of new-start construction that's happened in that space. So I think those are some of the elements that were slower from a macro perspective. We also had a large government order, about a $10 million government order that we anticipated happening in Q1. That is likely not to happen in the second half of the year. Keep in mind, that's not a market share loss. We're the sole source provider in the VA hospital space. And so that's something that was delayed further. Again, that was something we didn't expect. And I'd say one of the things that also came up with system, we talked about some operational issues and we identified that for you. It was really in Western Europe in our respiratory business. We had sort of self-identified some things from a quality and supply chain perspective that gave us some delay in terms of the timing of shipments. That's something we anticipate having resolved by the end of this quarter. Again, working through that as well. But it's -- there's nothing structural, nothing foundational in FLC, and we do anticipate that business continuing to recover over the course of the rest of the year. From a CCS perspective, again, I'll start with -- there are some phasing and timing of both -- I'd say the timing of orders. We've -- here's the good news. We've got a strong book of orders and that actually has continued to accelerate. But the timing of the first quarter, some of the orders came in later than anticipated, which then allowed us, again, there is some timing element of actually being able to ship some of those orders out. So I think that was certainly one element of that. And then installations, also from the actual installs was something that, in some cases, got pushed back to the later part of the year. Now we did talk about some operational impacts and then I'll just -- let me define that for you in terms of what that is and also maybe what it isn't. One of the main operational impacts we had related to CCS was as part of our supply chain initiatives, we're actually looking at rationalizing or optimizing our manufacturing footprint. And in this case, we actually went from 2 hospital -- 2 manufacturing facilities to 1. There's 1 in Massachusetts, 1 in Mexico, we consolidated that into Mexico, and that transition didn't go as smoothly as we'd like it to have gone. That's obviously something we're resolving and making good progress there, but certainly something more, again, temporary in nature and something we're addressing. I think the -- from a sales force standpoint, we continue to drive some of the sales culture in that sales force. There's -- there are things from an incentive perspective that we're working through. Historically, that team has been more annually incented than quarterly incented, which at times drives some variability in the timing of things. And so we're working through that. Also working through things like territory splits and utilization of technologies from a sales force perspective, from AI to help predictability of the funnel. And so long and short of it is, is that we are -- we had some impacts in Q1. And just as a reminder as well to people, we actually did -- we still are up against some rental revenues in the prior year that actually -- that should clear through in the second quarter, but that's a bit of a headwind we have. So all in all, a lot of stuff came together at one time. I think, really, the punch line here is that there's nothing -- it's not a structural issue or a market share loss issue, stuff we're working through and we remain confident in our ability to continue to move forward and the importance of this business to us.

What's giving you confidence that they're not losing share in some of these businesses? And then -- and two, the confidence that some of these things that are getting pushed out, that they're actually recoverable and not fully lost?

Yes. I mean, number one, I would tell you that the -- one of the things -- my early questions on this business was okay, so how does an order translate into a shipment? And what I would tell you, that [ barrier to entry ] is extremely high. So once you have -- and orders come in out of the -- there's a funnel, then there's orders. Once the orders come in, the likelihood of that shipping is very high. And so part of the confidence that I have is that as momentum continues to build in these orders, I think that's a big part of what we're seeing here. That also gives confidence in the shared -- I -- the business from a capital perspective, I'm not sure it's something to be able to look at on any single quarter basis and evaluate share. It's really around taking a look at the broader year. And so we -- again, just given the volume of orders and the work that's being done, we feel confident in that.

And Clare, too, when you think about the models and stuff like that, I want to make sure that Street is not getting too far ahead of itself on the recovery of this business. And so kind of what's the expectations for this business in Q2 and kind of the back half of the year?

Great question. So for the second quarter, we do expect it to continue to decline. It is expected to decline low single digits within Front Line Care as we continue to anniversary some of those comps, it's probably down closer to mid-single digits. On the CCS side, probably flattish, maybe down a little slightly but closer to flattish. Now that is sequential improvement for both businesses. So that's some meaningful sequential improvement, which will carry through the rest of the year. So I'd say the first half of the year, obviously, will be down. And as we've said, the second half of the year will be up closer to, I'd say that mid-single digits around that. For the year to end around flattish. It could be, again, plus or minus on that, but around flattish for the year, with Front Line Care ending the year down low single digits and the CCS business growing.

Super helpful. The other side on the quarter on that business was the margins as well. So touch on how much of that margin compression was just the revenue and how much of that gets recovered over the course of the year.

Sure. I'll start with that. So we do see significant margin progression for this business over the course of the year. Joel referenced earlier to this manufacturing rationalization, footprint rationalization that we had. We did have some incremental costs associated with that in the first quarter. Again, longer term, this will drive savings. But again, just given some increased logistics costs that did impact the margins in the first quarter of that, so that will resolve as we go through the year, and we actually get the benefit of shifting to this one location. In addition, obviously, this is a business where I will tell you, it's unlike some of our other businesses. The raw materials -- so the material component costs are actually kind of the biggest piece of the overall COGS. So we don't actually face as much of a volume issue, plus or minus on that. So as sales improve, you do get that benefit on the margin. And then also similar to this business, you have good leverage on the R&D and SG&A side. So you'll see that. We have implemented, though, some cost actions with this business as well. And those will start to carry out. And that's where you're going to really see meaningful margin improvement in the second half of the year relative to the first half of the year. And I expect you will have just to set margin expansion on a year-over-year basis for this business.

Okay. Any sense for how much at this point?

Yes. I mean, I'd say north of what we're calling for, for total Baxter, you'll see more than that in the HST business.

Got it. And then the Kidney business this quarter was actually on the upside and outperformed. Is that -- for at least the revenue side, is that strength, something we should expect for the rest of the year too? Or kind of puts and takes there?

Yes, I'll start with that. I mean, I think the -- certainly Kidney had a strong quarter. I think there are a couple of puts and a couple of takes, I would say, just to consider in that business. I mean, their acute therapies business was up 15% in this quarter. That's --that had some really strong demand, both in the U.S. and internationally. That's a solid margin business for that as well. So they certainly got some mix benefit out of that work. They did have, well, I guess, one what I'll call onetime benefit out of this that certainly should be thought about in the quarter and that is we had actually closed our Opelika facility. What that resulted in is kind of a surge, if you will, in terms of demand and production, if you will, that caused a level of absorption in terms of manufacturing that we don't anticipate, obviously, going forward. And so I think, just generally speaking, those are some of the puts in the business. And keep in mind, I mean, that's really good performance even against some of the things that they've been doing from a product and market exit perspective. So I think there's certainly strength that we're seeing there. We don't anticipate that same level of both top line and certainly in margin as the year goes by, but they're certainly going to continue to have a solid year.

Great. And then kind of putting the 2 together, I think looking -- thinking about the margin in the Renal business and the ex Renal business, a lot of the cost inflation was in the renal side. Any way to think about what your guidance, at least for this year, implies for year-over-year margin expansion in both of those businesses kind of Renal and ex Renal?

I'll start, and then I'll let Clare chime in. I mean, I think the way to think about our margins broadly and certainly, ex Renal in particular, is just the idea that we're going to have a few kind of key areas of margin expansion. One continues to be our ISC. I think the -- we have margin improvement program or manufacturing improvement programs that continue to drive the way that business is working in terms of automation, in terms of just various things that ultimately are helping us expand our margins and offset costs that might be coming through from an inflationary perspective. We certainly continue to think about pricing. I think as we've talked about, we renegotiated contracts with GPOs. We right now are negotiating the IDN portion of that equation, but we anticipate pricing continue to be a favorable outcome. And certainly, there's a mix component to this as well. We've talked about this year where some of the areas of our business that actually caused, again with HST being down, our anticipation for that improvement next year. We have a high level of compounding growth in our pharma business. And again, so I think there will also be in anticipation of some favorable margin benefit from mix. And finally, what I would just say is new product innovation. There's again, certainly, starting with Novum, where that certainly has -- will have now a full year effect of that as well as products that are coming in. We had 13 product introductions coming on in our pharma business. We have products coming on the HST. There's -- so I think just generally, innovation is going to help cause -- continues to drive margin enhancement. Anything you'd add there?

No, I think -- the only other consideration obviously for this year in terms of if you think about Baxter margins ex Kidney is just absorbing the incremental costs associated with moving to a contract manufacturer within our pharmaceuticals business. So previously, our BPS business, obviously, we're self-manufacturing some pharmaceuticals. We've now moved that to a cost-plus arrangement. So that will be in the base as we go into next year. And we're continuing to launch products and launching those products that really more leverage our own manufacturing, so it will become less, but that's a year-over-year headwind for us this year.

Particularly in the first half of the year.

Yes.

And so just to put some numbers around that, the Kidney business in 2023 had 6.7% operating margins. In '24, is that 10%, 12%, just kind of a sense for what that is in 2024, on a full year?

Yes. I mean, I will say that we expect meaningful improvement in 2024. So I'd say probably towards that low double digits. I don't think 12% is probably -- I think that's probably too high at this point, so at the lower end of that. The one thing just to note is we will start to incur some increased supply chain costs and logistical related costs. As we continue to prepare for the separation, we are moving to more of a 1 plant, 1 segment approach. And so initially, Kidney will incur some increased supply chain and logistics costs as they kind of work to optimize their distribution over time. But in the meantime -- and that will start in the second quarter. And then, I think, over time, they'll be able to address some of that, but that will cause some margin pressure this year as well.

And then the HS&T drag on the ex Renal business, that margins probably are down versus the 18% last year, I would assume with HS&T?

So BAX ex Renal?

Ex Renal, yes.

Yes. I mean, again, what I would tell you is HST going to grow year-over-year. MPT is anticipated to grow year-over-year. It is the pharmaceuticals and more driven by the BPS side of it. So those are, really, the kind of the main things. Otherwise, you -- we are seeing underlying margin improvement on a year-over-year basis for those. So -- and just back to the pharma, and Joel referenced this earlier, over the course of this year, we will see meaningful margin improvement from the first quarter. Mix is part of it. We did have a good quarter within the pharmacy compounding, but we're continuing to look for ways to enhance the overall profitability of that business. It is a lower-margin business. There's tremendous demand for our services, but we have to make sure that we continue to optimize this from a profitability standpoint. We are focused on launching those injectables, which are higher margin, so we'll continue that rollout. And then in addition, there are some manufacturing improvement programs like there are across all of our businesses. And then finally, just leverage as well. We had some investments we made in sales and marketing in the first quarter ahead of the new product launches that we have, so we'll get better leverage out of those -- the OpEx pieces towards the second half of the year.

And the pricing, is that -- I know you've been getting a little bit of a benefit from price already this year. Is that incrementally better next year when you do some of the repricing on that ex Renal business?

Yes. That's how I would think about it.

Yes.

And I think one of the other differences this year is, just to be clear, we're -- the pricing we're getting this year is primarily in the -- outside the U.S. and certain outside U.S. markets. One of the things to remember is that in 2023, we had actually taken some I'll call temporary price measures with our GPOs in the U.S. that we're up against this year, which is why, from the U.S. perspective, our pricing looks the way it does. But again, OUS this year again -- next year with some of the, again, the anticipated impact of some of the GPO negotiations, we are considering that as another incremental impact from pricing.

Does -- the negotiations that happen this year, that kind of reprices in January 1 next year?

Early January.

It's in the month of January, yes. I don't think it's January 1, but it's in the month, it's early.